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China Automotive Systems, Inc. (NASDAQ:CAAS)

Q4 2013 Earnings Conference Call

March 31, 2014 09:00 AM ET

Executives

Hanlin Chen - Chairman

Qizhou Wu - CEO

Jie Li - CFO

Daming Hu - CAO

Kevin Theiss - IR, Grayling

Analysts

William Gregozeski - Greenridge Global

Operator

Greetings and welcome to the China Automotive Fourth Quarter and Full-Year 2013 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kevin Theiss of Grayling. Thank you, sir. You may begin.

Kevin Theiss

Thank you for joining us today and welcome to China Automotive Systems 2013 fourth quarter and fiscal year conference call. My name is Kevin Theiss, and I am with Grayling, China Automotive's U.S. Investor Relations Advisor.

Joining us today are Mr. Hanlin Chen, Chairman; Mr. Qizhou Wu, Chief Executive Officer; Mr. Jie Li, Chief Financial Officer; and Mr. Daming Hu, Chief Accounting Officer of China Automotive Systems. They will be available to answer questions later in the conference call. We will help them with translation.

Before we begin, I’d remind all listeners that throughout this call, we may make statements that may contain forward-looking statements. Forward-looking statements represent our estimate and assumptions only as of the date of this call. As a result, the Company's actual results could differ materially from those contained in those forward-looking statements due to a number of factors including those described under the heading Risk Factors in the Company's Form 10-K Annual Report for the year-ended December 31, 2013 filed with the Securities and Exchange Commission on March 31, 2014, respectively; and the documents filed by the Company from time-to-time with the Securities and Exchange Commission. The Company expressly disclaims any duty to provide updates to any forward-looking statements made in this call whether as a result of new information, future events or otherwise.

I’ll provide a brief overview and summary of the 2013 fourth quarter and fiscal year results. And then I will turn to management to conduct the question-and-answer session. The 2013 fourth quarter are unaudited numbers, while the fiscal year numbers are audited, both periods results are reported under U.S. GAAP. For our call today, I will review the financial results in U.S. dollars.

Industry overview. We achieved record sales in 2013 as our market leading position increased further in a rising automotive market in China. Chinese government policies designed to reduce emission -- of vehicle emissions stimulated growth in both the passenger and commercial vehicle segments in 2013 and continue in early 2014. We capture share in each segment as our growth surpassed each markets growth in 2013. Higher unit sales increased capacity utilization in economies of scale generating improved profit margins.

Investments in research and development have yielded innovative new product such as our rapidly growing electric power steering, EPS, for the domestic Chinese market and new products that provide high customer value to drive our export sales to Chrysler in North America.

Our strategy of leveraging our leading market position in the domestic Chinese brands to penetrate different market segments has developed our two largest customers in 2013, Chrysler North America and SAIC-GM-Wuling, a foreign joint venture in China.

We continue to increase our market share in the fourth quarter in 2013 year. Our fourth quarter sales increased 27.3% in 2013 compared with industry vehicle growth of 17.3%. And our annual sales growth were 23.6% in the 2013 year surpassed industry vehicle growth of nearly 14%, according to statistics from the China Association of Automobile Manufacturers, CAAM.

We gain market share in both passenger and commercial vehicles in 2013, a 29.3% growth in sales with the passenger vehicle market in 2013 exceeded the 15.7% increase in total passenger vehicle sales.

The Chinese government’s incentive policy with the purchase of low-emission cars and fuel-efficient cars encouraged passenger vehicle sales in 2013. We believe the outlook remains positive for the -- these incentives to stimulate passenger vehicle sales growth going forward.

In the commercial vehicle market, our 11% growth increase eclipsed the 6.4% increase in commercial vehicle sales caused by the rise in infrastructure spending on projects such as railways and highways and the pre-buy of national three emission standard vehicles prior to the nationwide enforcement of the new national four emission standard.

Our higher growth rates were mainly due to increased sales of new and upgraded products, generating an improvement in market share in China, especially among foreign joint venture brands and our exports. We started shipping to Chrysler North America in 2008 and they quickly became our largest customer.

Sales in the United States increased 17.4% in the 2013 year as we supplied steering gear to three separate vehicle models controlled by Chrysler, the Jeep Wrangle, the Dodge Van 2500 and model 3500 pickup trucks and we also produced one after market product.

Additionally, large sales to SAIC-GM-Wuling, knows as SGMW, and its best selling Hongguang brand, multi-purpose vehicle in China has propelled to become our second largest customer within a year of initial shipments. Dongfeng Peugeot Citroen, a top 10 customer expanded this production capacity in July 2013 to 750,000 vehicles in China with a new assembly plant.

Sales in the commercial market in 2013 benefited from higher sales, especially heavy duty trucks due to the continuing pre-buy of lower cost national three emission standard vehicles before the nationwide enforcement of the national four emission standards that began on July 1, 2013.

In addition, we believe we’re in early stages of the new five-year vehicle replacement cycle to replace older vehicles with more updated models. Future sales growth will benefit as the cycle intensifies. With advanced product strengthening our relationships with more than 60 OEMs, we look forward to enhanced sales in both the passenger and commercial vehicle markets over the next several years.

Our research and development has developed global quality products and upgraded traditional steering technologies. We were the first to domestically design and introduce electric power steering into the Chinese market. EPS is widely accepted in foreign markets due to its ability to improve fuel efficiency and we’re driving sales with its introduction.

With our technology and cost advantage, we more than doubled our EPS sales in the 2013 fourth quarter, as more customers are demanding the fuel efficiency advantage -- advantages it offers. Our EPS technology enhances steering in domestically branded vehicles and offers a highly competitive cost competitive product to capture market share from higher priced imported EPS systems.

We are designing new generations of EPS to further enhance its fuel efficiency and applicability to more vehicles in the Chinese market. We generated our broad customer base of over 60 OEMs, foreign joint ventures, SGMC, FAW Volkswagen and Dongfeng Peugot Citroen and exports to North America with superior steering products created by our scientist and engineers.

In fact, during 2013 Chrysler again honored China Automotive Systems for its product excellence and service as we were the sole winner of Chrysler’s 2013 Supplier of the Year Metallic. Two years in a row we’ve received accolades from Chrysler indicating we’re meeting or exceeding the requirements of a major global vehicle manufacturer requiring cost effective advanced products of the highest quality.

We continue to target other OEMs with a global reach as we believe the price, performance and quality of our steering products are appealing. Apart of the long-term business strategy is to increase international sales to other markets where we believe we’ve an advantage or face inferior competition.

At December 31, 2013 our cash and short-term investment of $89.5 million was at our historical high, despite spending $15 million on capital expenditures, a $10.1 million increase in operating expenses and a $2.9 million reduction in short-term bank debt. We’ve continued to maintain zero long-term debt.

Net cash provided by operations for the year ended December 31, 2013 was $13.2 million. We’ve demonstrated our cash flow generation capabilities over time to internally finance our research and development and capital expenditures.

With advanced products and growing production efficiencies, we can enhance our customer relations and capture market share. We will continue to build our market share, our market leadership in the Chinese steering market to generate stronger cash flow and financial position.

We will use these resources to further enhance our innovative R&D, improve manufacturing productivity and expand our marketing to achieve our vision of the Company leading providing -- provider of steering products to the global market.

Now let me walk you through our fourth quarter and fiscal year 2013 financial results. In the fourth quarter of 2013, net sales increased 27.3% to a fourth quarter record of $129.2 million compared to $101.5 million in the same quarter of 2012. The net sales increases mainly due to the more than doubled sales of electronic power steering products and significant sales to customers such as Chrysler North America, SAIC-GM-Wuling Automobile, Great Wall and Brilliance Auto, all of which experienced rapid growth in 2013.

Gross profit increased by 30.2% to $22.4 million in the fourth quarter of 2013 compared to $17.2 million in the fourth quarter of 2012. The gross margin was 17.3% in the fourth quarter of 2013 versus 17% in the fourth quarter of 2012. The increase in gross profit was primarily due to greater sales volume. The increase in gross margin was mainly because of a decrease in unit material cost associated with better economies of scale and the adoption of technical innovations in our production processes in 2013.

Gain on other sales was $0.8 million in the fourth quarter of 2013 as compared to $1.8 million in the fourth quarter of 2012. The decrease was mainly due to a gain of $0.9 million on the sale of properties, plants and equipment in the fourth quarter of 2012.

Selling expenses rose by 27.6% to $3.7 million in the fourth quarter of 2013 compared to $2.9 million in the fourth quarter of 2012. Selling expenses represented 2.9% of our net sales in the fourth quarter of 2013, which remain the same as the fourth quarter of 2012. The increase in selling expenses was primarily due to the increases in compensation to salesmen, warehouse rental fees, and transportation expenses as a result of higher sales volumes.

General and administrative expenses, G&A declined by 25.8% to $3.1 million in the fourth quarter of 2013 compared to $3.9 million in the same quarter of 2012. The decrease in G&A expenses was primarily due to a reimbursement of our legal expenses of $0.6 million by the Company’s insurance policy in the fourth quarter of 2013 and a decrease of depreciation and amortization, which was mainly due to certain office equipment that continued to be utilized in the fourth quarter of 2013 having been fully depreciated at the beginning of the year. G&A expenses represented 2.4% of net sales in the fourth quarter of 2013 and 3.8% in the fourth quarter of 2012.

Research and development expenses, R&D increased by 62.5% to $7.8 million in the fourth quarter of 2013 compared to $4.8 million in the fourth quarter of 2012. The increase in R&D expenses was mainly due to development and trial production of the Company's electric power steering systems and other new products, as well as improvement in production mold and higher external technical support fees. R&D expenses represents 6% of net sales in the fourth quarter of 2013 compared with 4.7% in the fourth quarter of 2012.

Operating income increased by $1.2 million or 16.2% to $8.6 million in the fourth quarter of ’13 compared to $7.4 million in the same quarter of 2012. The increase was mainly due to the higher gross profit in the fourth quarter of 2013 compared to the fourth quarter of 2012. As a percentage of net sales, the operating margin was 6.6% in the fourth quarter of 2012 compared to 7.3% in the fourth quarter of 2012.

Net financial income was $0.05 million in the fourth quarter of 2013 compared to net financial expenses of $0.3 million in the fourth quarter of 2012. The Company’s higher time deposits generated greater interest income while a decrease in bank loans in the third quarter of 2013 reduced interest expense for the fourth quarter of 2013.

Income before income tax expenses and equity in earnings of affiliated companies was $9.2 million in the fourth quarter of 2013, compared to $7.2 million in the fourth quarter of 2012. The increase was mainly due to increased operating income of$1.2 million and a $0.4 million reduction in financial expenses.

Net income attributable to parent company’s common shareholders was $7.2 million in the fourth quarter of 2013, compared to net income attributable to parent company’s common shareholders of $5.1 million in the corresponding quarter of 2012. Diluted earnings per share were $0.26 in the fourth quarter of 2013, compared to diluted earnings per share of $0.18 in the fourth quarter of 2012. The weighted average number of diluted common shares outstanding was 28,062,553 in the fourth quarter of 2013, compared to 28,076,879 in the fourth quarter of 2012.

Fiscal year 2013. Annual net sales increased by $79.2 million, or 23.6%, to $415.2 million in 2013, compared to $336 million in 2012. The Chinese government issued an incentive policy related to repurchase of low emission cars and fuel efficient cars in May 2012 encouraged by such incentive policy. Sales value of passenger vehicles in the China market increased by 15.7% in 2013 as compared to 2012.

The Company’s sales volume of steering gears for passenger vehicles increased by a higher rate of 23.9% as compared to 2012. The Company’s higher rate of increase was mainly due to its introduction of certain new products to the market and the improvement in the quality of some of its older products, which resulted in the expansion of the Company’s market share in China, especially among the joint-brand auto customers.

The Company had an increase in sales volume leading to a sales increase of $78.4 million, a decrease in selling price leading to a sales decrease of $8.1 million and the effect of foreign currency translation of the RMB against the U.S. dollar resulting in a sales increase of $8.9 million.

Gross profit in 2013 increased by 26% to $76.6 million from $60.8 million in 2012. Gross margin in 2013 was 18.5% compared to 18.1% in 2012, which was primarily due to greater sales of higher margin products.

Selling expenses in 2013 increased by 38.5% to $13.3 million in 2013 from $9.6 million in 2012, which was mainly due to the higher transportation expenses related to the increase in unit volume and increased staff compensation. Selling expenses represented 3.2% and 2.8% of net sales in 2013 and 2012 respectively. The Company continues to focus on increasing the market share in China by expanding its sales team.

G&A expenses increased by $0.4 million or 3.1% to $13.3 million in 2013 from $12.9 million in 2012. Higher G&A expenses were primarily due to increased staff compensation as a result of higher performance bonuses payable to management for strong operating results, greater labor insurance cost and an increase in property taxes due to the increase of the property holdings. G&A expenses represented 3.2% of net sales in 2013 compared to 3.8% in 2012.

R&D expenses increased by $6 million or 40.3% to $20.9 million in 2013 from $14.9 million in 2012 primarily due to the cost incurred for the company’s further development of its EPS technology with the improvement of machinery moulds and higher staff compensation cost. The increase in R&D investment has yielded several models of EPS for small cars in China. R&D expenses represented 5% of net sales in 2013 which was an increase from 4.4% of net sales in 2012.

Operating income increased by 32% to $36.7 million in 2013 from $27.8 million in 2012 due to higher gross profit and higher gain on other sales from material scraps, fixed assets and land use rights. The operating margin represented 8.8% of net sales in 2013 compared to 8.3% in 2012.

Net financial income was $0.4 million in 2013 compared to net financial expenses of $2.2 million in 2012 as interest expenses were reduced after the redemption of all outstanding convertible notes in May 2012 which was slightly offset by higher interest income on higher cash balances in 2013. There was no gain or loss on changing the fair value of the derivative embedded in the convertible notes in 2013 after the redemption of all convertible notes in May 2012.

The Company recorded a loss on changing the fair value of the derivative embedded in the convertible notes of $0.4 million in 2012. There was no gain on redemption of convertible notes for the year ended December 31, 2013. The Company recorded a gain of $1.4 million in the redemption of convertible notes in 2012.

Income before income tax expenses and equity and earnings of affiliated companies was $38.2 million in 2013 compared to $27.1 million in 2012 representing an increase of $11.1 million or 41%. The increase is mainly due to an increase in income from operations of $8.9 million a decrease in financial expense of $2.6 million and a decrease in gain on the redemption of convertible notes of $1.4 million.

Income before taxes and equity and earnings of affiliated companies represented 9.2% of net sales in 2013 compared to 8.1% in 2012. Income tax expense was $5.5 million for the year ended December 31, 2013 compared to $4.4 million for the year ended December 31, 2012 represent an increase of $1.1 million or 25%. This tax increase was mainly due to higher income before tax and a decrease in the effective tax rate.

Effective tax rate decreased to 14.4% for the year ended December 31, 2013 from 16.2% in 2012, primarily due to an increase in tax deduction of R&D expenses in 2013. The Chinese government rewards high-tech companies with favorable tax rates.

Net income attributable to parent company's common shareholder was $26.8 million in 2013 compared to $20.7 million in 2012. Diluted earnings per share were $0.95 in 2013 compared to $0.70 in 2012. Weighted average number of diluted common shares outstanding was 28,056,144 in 2013 compared to 28,215,367 in 2012.

As of December 31, 2013 total cash and cash equivalents and short-term investments were $89.5 million compared to $87.6 million as of December 31, 2012. Working capital was $179.3 million as of December 31, compared to $138 million, $0.8 million as of December 31, 2012. Total parent company stockholders equity was $226.7 million as of December 31, 2013 compared to $193.6 million as of December 31, 2012.

Management revenue growth target is 15% year-over-year growth for the full-year 2014. This target is based on the company’s currently used on operating and market conditions which are subject to change.

With that, operator we are ready to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Thank you. Our first question comes from the line of William Gregozeski with Greenridge Global. Please proceed with your question.

William Gregozeski - Greenridge Global

Hi, congratulations on the good quarter. Could you -- if you can, can you breakout the unit sales of the EPS product in fourth quarter and for the full-year 2013?

Unidentified Company Representative

So we sold 44K units of EPS in 2012 and about 20K units in 2013. We don’t have the number for the fourth quarter of 2013 at hand.

Unidentified Company Representative

Actually just a [mix of] [ph] mission here, it was around 80,000 units something like that for the fourth quarter of last year.

William Gregozeski - Greenridge Global

Sorry, can you repeat those numbers again.

Unidentified Company Representative

So 2013 we have over 200,000 units, at 2014 we’re expecting double.

William Gregozeski - Greenridge Global

Okay, great. And then is there anything with the year or -- or else a while ago you had announced the Beijing Henglong, is there anything that’s going to happen with that in the near future?

Unidentified Company Representative

So, the factory is being built and we are currently in talks with Beijing, and also that the Beijing Hyundai has come and had talks with us, numerous occasions already.

William Gregozeski - Greenridge Global

Okay. Do you think you’ll be selling under that JV this year?

Unidentified Company Representative

Okay, so the sales are indeed going to take place through the JV at once on the specific car motors. At the moment we’re in talks with them on the, (indiscernible) providing the [SAIC] [ph] 93 and 96 models, so that the after-sales is going to add in on the progress on the side of Beijing as well. Meanwhile we’re also talking to them on the Hyundai and the Jeep models also, and the factories are being built. So that’s the current status of this JV project.

William Gregozeski - Greenridge Global

Okay. And is there any gross margin expectation that you can provide for 2014?

Unidentified Company Representative

So, our gross margin for 2013 was 18.5% and we currently expect a slight increase for 2014 mainly due to three reasons. Number one, being that the price is remaining stable and the second one is because our raw material cost continues to be low and the third reason is because our expected doubling in the EPS sales units, which as you know are higher margined.

William Gregozeski - Greenridge Global

Okay, great. Thank you, guys.

Unidentified Company Representative

Thank you.

Unidentified Company Representative

Thank you.

Operator

(Operator Instructions) Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Kevin Theiss

Thank you to all for participating in our fourth quarter 2013 earnings conference call. We look forward to speaking with you again and wish you all a good day.

Unidentified Company Representative

Thank you.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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